The Federal Unemployment Tax Act: credit reduction or tax increase?

Robert Gialamas
Robert Gialamas, FPC is president of Paytime Payroll Processing, an integrated payroll service provider located in Solon.

It goes without saying that unemployment impacts our daily lives as business owners in countless ways. We will be hearing a lot about its effects on a larger scope in the coming months.
However, in lieu of political discourse and messy banter on unemployment, potential tax hikes, spikes, and adjustments, it's vital to understand some basic information on the FUTA tax, and to clear the air surrounding the confusing language used to describe it. Most importantly, companies should consider how they can do some short and long-term planning so they are prepared for any changes reflected in their business' FUTA tax credit.
In short, The Federal Unemployment Tax Act (FUTA) is a law that supports unemployment compensation for workers who have lost their jobs and qualify to receive unemployment benefits. This law mandates employers pay a tax that supports the federal program. The FUTA tax was established in1939 as a flat employer paid tax set at 6% of the first $7000.00 earned by each employee on payroll each year. Those employers who pay their state unemployment tax (SUTA) on time and in full receive a full tax credit of 5.4%, making the effective tax rate 0.6%. However, if this were not confusing enough, the act also allowed for a reduction in this 5.4% FUTA tax credit in cases where individual state unemployment systems borrowed from the federal unemployment fund and were not able to pay back the loan timely. States that fall under this category are known as credit reduction states.
The state's debt impacts the employer's ability to receive a full 5.4% FUTA tax credit. Federal law provides for a reduction in the FUTA tax credit when a state has depleted its unemployment funds and had to borrow from the federal unemployment loan account.
• Employers in credit reduction states should budget for a decrease in FUTA tax credit on the 2012 Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return.
For many of us who land in these credit reduction states, it should be noted here that credit reduction is not a FUTA tax increase, but rather a “reduction in FUTA credit”. The net effect is employers in credit reduction states will pay more FUTA tax. The actual FUTA tax rate is still 6%. The offsetting FUTA credit however is being reduced. This credit, granted to individual employers who remain in good standing in regard to FUTA payment, will decrease because the state in which the employer does business has defaulted on its loan.
The FUTA Credit will decrease by .3% in 2012
• States showing a .3% credit reduction in 2011 will increase to .6% in 2012 resulting in a FUTA credit of only 4.8%.
• States showing a .6% credit reduction in 2011 will increase to .9% in 2012 resulting in a FUTA credit of only 4.5%.
In 2011, employers in twenty states received FUTA credit reductions. These states are referred to as “credit reduction” states because they have outstanding loans for at least two years. When a state falls behind on its loan payments, employers in those states lose part of the FUTA tax credit. Unfortunately, many states have found it difficult to repay the loans in a timely fashion, so those doing business in more long-term credit reduction states continue to experience additional reductions.
As many as seven new states (AL, AZ, CO, DE, KS, SC, and VT) may experience credit reductions this year. State unemployment insurance agencies have until November 10th, 2012 to repay a loan and avoid a credit reduction for the calendar year in which the loan balance is repaid. Notification of credit reductions is made available after November 10th. This can pose an additional challenge to employers trying to plan budgets accordingly because by this date, employers have already submitted three quarterly FUTA deposits. All added FUTA tax debt must be paid with the final deposit for the calendar year (due January 31st of the subsequent year).
Which States were FUTA Credit Reduction States for 2011?
The following 20 states had outstanding Federal Unemployment Trust Fund loans:

Arkansas

0.3%

Kentucky

0.3%

North Carolina

0.3%

California

0.3%

Michigan

0.9%

Ohio

0.3%

Connecticut

0.3%

Minnesota

0.3%

Pennsylvania

0.3%

Florida

0.3%

Missouri

0.3%

Rhode Island

0.3%

Georgia

0.3%

Nevada

0.3%

Virginia

0.3%

Illinois

0.3%

New Jersey

0.3%

Wisconsin

0.3%

Indiana

0.6%

New York

0.3%

Schedule A (Form 940)
Employers in credit reduction states must use the Schedule A (Form 940) to calculate the credit reduction and attach the Schedule A to their Form 940. Additional information on the credit reduction, including an example of how to calculate the credit reduction is available on the Schedule A (Form 940) and also in the Instructions for Form 940.
What you can do is plan ahead based on the 0.3% calculation. If you are an employer filing taxes in a credit reduction state, it is important that you prepare financially for this credit reduction. Keep in mind, some states offer an unemployment tax credit to employers who, for example, have a positive reserve balance.

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